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Why investors should consider municipal bonds despite Puerto Rico

Phalguni Soni

Why investors should consider municipal bonds despite Puerto Rico (Part 1 of 7)

Municipal bonds

The municipal bond (RVNU) market’s debt outstanding on December 31, 2013, stood at ~$3.7 trillion, making up about 9.2% of the total outstanding debt in the U.S. About 44% of the total municipal debt outstanding was held by individual investors.

What are municipal bonds?

Municipal bonds (or munis) are issued by state and local governments or their agencies to finance capital expenditure. Capital expenditure consists of spending on public projects like schools, highways, hospitals, and the like. Munis (VRD) are particularly attractive to individual investors, as the interest income from munis is exempt from federal taxes and sometimes state and local taxes as well. Besides, investing in munis issued by local governments allows individuals to participate in public projects in their vicinity. For a detailed explanation of the tax advantages and other benefits of munis to individual investors, please refer to Part 6 of this series.

Investors can purchase muni bonds either directly from the issuer (which rarely happens) or through the secondary market. As they’re sold in increments of $5,000, retail investors may find it easier instead to purchase shares in an ETF that specializes in municipal bonds. This would give the investor diversification benefits by providing exposure to muni bonds from different issuers, while at the same time, the investment could be made for sums less than $5,000 increments.

Major ETFs investing in municipal bonds include the db X-trackers Municipal Infrastructure Revenue Bond Fund (RVNU), the Invesco PowerShares VRDO Tax Free Weekly Portfolio (PVI), and the PowerShares Insured National Municipal Bond Portfolio (PZA).

This series will discuss the major types of municipal securities (PVI) available for investment and how investors can benefit from these in the current environment. We’ll also discuss the major advantages of investing in munis and the risks in doing so. We’ll consider the impact of the current investment environment on muni bond ETFs and S&P 100-listed (OEF) companies like Caterpillar (CAT).

To read about some of the major muni bond variants, please continue to Part 2 of this series.

Continue to Part 2

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